Step aside Bitcoin, central bank digital currencies can be the real disruptors, S&P says​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​​

Cryptocurrencies are too volatile and are merely speculative investments, Mohamed Damak says

A Bitcoin ATM sign in New York. The US plans to publish a discussion paper this summer that will outline its current thinking on digital payments. Reuters

Central bank digital currencies have the potential to be the real disruptor in the financial sector, as opposed to cryptocurrencies that are merely a tool for speculative investment, according to S&P Global Ratings.

“The price of a cryptocurrency is volatile and it can go down, but what cannot go down is the price of a CBDC,” Mohamed Damak, a senior director at S&P Global Ratings, said on Sunday.

“A digital dollar will always remain a digital dollar, unless the Fed decides otherwise.”

People trust central banks to create digital currencies and "we think the CBDC will be the real disruptor here", he told The Future of Banking virtual seminar.

“We believe that central banks will have a clear preference for a CBDC model where banks and financial institutions still have a role to play."

Based on this assumption, the ratings agency expects a moderate effect on banks' business models going forward, which could result in some pressure on revenue generated by activities such as payment services. However, depending on the model central banks choose, CBDCs could “meaningfully influence” even monetary and fiscal policies in the future, Mr Damak said.

Central banks around the world are looking into the development of digital currencies amid the growing popularity of cryptocurrencies as an asset class among both retail and institutional investors.

China was one of the first major economies to look at the potential of a CBDC in 2014 and it has already started limited trials of its digital currency.

In April, the Bank of Japan said it would begin a series of experiments for a digital yen and the UK Treasury and Bank of England said they would establish a task force to develop a "Britcoin".

Last month, US Federal Reserve chairman Jerome Powell announced plans to publish a discussion paper this summer that will outline its current thinking on digital payments.

On Saturday, G7 finance ministers and central bank governors committed to work together on CBDCs to develop an understanding "on their wider public policy implications".

"We note that any CBDCs, as a form of central bank money, could act as both a liquid, safe settlement asset and as an anchor for the payments system. Our objective is to ensure that CBDCs are grounded in long-standing public sector commitments to transparency, the rule of law and sound economic governance," the policymakers said in a joint communique.

CBDCs will help build “trust across the ecosystem” but their development will still take some time, Mr Damak said.

“I am not sure if the central banks are ready for this big bang yet.”

In the meantime, cryptocurrencies will continue to exhibit volatility. They are purely “speculative investments and we don’t even call them payment solutions”, he said.

There are 5,500 cryptocurrencies in the world with a combined market capitalisation of up to $2 trillion, which is equal to Apple’s value. Given the high number of retail investors invested in cryptocurrencies, “they are the ones to lose money” if prices plunge, Mr Damak said.

Among the flaws of cryptocurrencies is their exorbitant power consumption, with investors that follow environmental, social and corporate governance guidelines expected to be “de facto excluded” from putting money into them.

Although banks and financial institutions do not have significant financial exposure to these currencies, they face the risk of “mis-selling” if they help their clients to invest in cryptocurrency exchange-traded funds without fully explaining the risks.

Unlike many of its global peers, Europe's biggest lender HSBC last month said it has no plans to set up a cryptocurrency trading desk or offer the digital coins as an investment because they are too volatile and lack transparency. However, the bank is a believer in CBDCs, HSBC chief executive Noel Quinn said.

Bitcoin, the world's largest digital currency, has slumped about 50 per cent from its year high of $64,895 on April 14 to trade at $36,144 on Monday at 11.56am UAE time.

Banks also face the risk of customer defaults on loans and credit card used to invest in cryptocurrencies, "which could have some impact on their asset quality", Mr Damak said.

Globally, lenders are also facing mounting pressure from the FinTech industry.

Many lenders in the GCC have embarked on digital transformation programmes to keep pace with the changing dynamics of the financial services industry.

As the primary source of funding to fuel regional economies, banks are being protected by regulators to some extent, but are already facing competition in areas like payments systems, where costly and inefficient processes are being taken over by more efficient and cost-effective solutions by FinTech companies, Mr Damak said.

Although the profitability of some GCC banks declined in 2020 due to pandemic-driven headwinds that led to lower lending growth, smaller margins and higher costs of risk, they have been resilient and managed to shift their businesses online with “minimal disruption”.

“Demand for FinTech solutions is present and expanding”, and banks have realised that. However, “we see a stronger focus on costs with reduction of branch networks and staff relocations to cheaper locations", Mr Damak said.